Category Archives: HSA mechanics

Contributing to HSA’s with a Cafeteria Plan

What are Cafeteria Plans

To understand Cafeteria Plans and HSA’s, it helps to understand the mechanisms for contributing funds to your Health Savings Account. There are four different ways to contribute to an HSA, all of which count towards your yearly contribution limit:

  1. Your employer contributes their money to your HSA. In this case, your employer gifts you funds directly into your Health Savings Account during the tax year. This is by far the best way to fund an HSA since the money is free and being given to you. Employer contributions count towards your yearly contribution limit but they are yours to spend as you like.
  2. You contribute after tax money to your HSA. This usually occurs by depositing cash or transferring funds between your bank account and your Health Savings Account. You have likely paid taxes on these funds (via payroll) so HSA tax Form 8889 helps you account for them and refund those taxes paid.
  3. You contribute from your IRA or Roth IRA. This is called a Qualified Funding Distribution and moves money from one tax advantaged investment account to your HSA. Do note that these contributions contain a Testing Period,
    requiring you to maintain HSA insurance.
  4. Your employer withholds your earnings pre-tax and contributes them to the HSA. This is an example of a what is called a cafeteria plan. These funds are yours (since they are being paid to you and are no longer your employer’s) and are a part of your paycheck. The employer is just enabling the contribution for you through their payroll system.

Cafeteria Plans are not unique to HSA’s; in fact, it is a general term used to describe pre-tax contributions made by your employer. They can be established for a variety of employee related savings or expenses.

A Cafeteria Plan is a reimbursement plan governed by IRS Section 125 which allows employees to contribute a certain amount of their gross income to a designated account or accounts before taxes are calculated.

Benefits of HSA Cafeteria Plans

There are numerous benefits of cafeteria plans that not only make your life easier, but actually end up saving money. Besides all of the advantages of savings in an HSA, here are some additional benefits that contributing via a Cafeteria Plan provides:

  • You pay less taxes. You read this right, Cafeteria Plans reduce the amount of taxes you pay. This is because payroll tax is not the only tax you pay each paycheck. In addition, you pay into other programs such as Medicare, Social Security, and any state taxes that are taken from your earnings. When you file Form 8889 as part of your tax return, you will only be credited for the income tax that was paid. The other taxes stay with Uncle Sam. Using a cafeteria plan allows you to make these contributions before all these payroll taxes hit it, allowing you to keep a larger slice of your earnings.
  • Disciplined savings. One of the hardest things about saving is actually putting aside the money to save. There is always something that comes up or something tempting you as a “more fun” use of the money. Saving via a Cafeteria Plan eliminates this because you automate your savings plan and the money is taken pre-tax. It never even hits your checking account as it goes straight to the HSA, preventing you from spending it and making sure you make your contribution.
  • Easier transactions. I never had the luxury of a cafeteria plan so each month I had to initiate a transfer to my bank to make the contribution. Having this taken care of for you reduces the amount of work you have to do and transfers you make with your money.

If you are presented the option for contributing to an HSA via cafeteria plan you should definitely consider it, based on the benefits above. Their main drawback is decreased flexibility in changing HSA contributions, since they are happening automatically from your paycheck. For example, it may take time to adjust your HSA contribution amount during the year. There may be a lockout period, a delay before it takes effect, and you at least have to talk to HR to make the change. You should evaluate how your specific payroll plan handles changes to HSA contributions via a cafeteria plan and assess whether that is suitable to your needs before signing up.

Reporting Cafeteria Plan Contributions on Form 8889

The biggest mistake people make with Cafeteria Plan contributions and filing HSA tax Form 8889 is putting them on Line 2. Line 2 is where contributions you personally made (#2 above) are totaled and used to reduce your taxable income. This has the effect of making your contributions tax free. You can see that by adding Cafeteria Plan contributions to this line, you are “double dipping” because you never paid taxes on those contributions to begin with. Line 2 has a disclaimer that calls this out:

Do not include employer contribuitons, contributions made through a cafeteria plan, or rollovers in Line 2 (see instructions)

Form 8889 Line 2

Due to the IRS’ confusing wording, most people don’t even know they are contributing through a cafeteria plan or what one is. Thus, they end up making a mistake on Form 8889 and potentially receiving a call from the IRS.

The correct place to put contributions made through a cafeteria plan is on Line 9 of Form 8889, which is called “Employer Contributions”. This makes sense because, in our discussion above, we saw how cafeteria plan contributions look a lot like employer contributions. There is no taxes being paid on both of these contributions, it is just a matter of whose money is being contributed. Again, the IRS doesn’t help us with Form 8889 because they describe the line as “Employer contributions made to your HSA for 2017”.

Form 8889 Line 9

If you look into the Form 8889 instructions, you can see that this is the exact spot where Cafeteria Plan contributions should go:

Form 8889 Line 9 Instructions

Doing so will ensure the amount that travels over to your 1040 form is the correct amount to deduct.

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HSA 55+ Catch Up Contribution When Spouses Have Separate HSA’s

You are probably aware that Health Savings Accounts have a contribution limit that changes slightly each year, and that your coverage (self-only or family) determines how much you can contribute to your HSA. For example, the contribution limits for 2017 are $3,400 for self-only coverage and $6,750 for family coverage. In addition, there is a catch up contribution for those that are 55 or older before the end of the year in the amount equal to $1,000. The IRS defines this catch up contribution in Form 969:

Additional contribution. If you are an eligible individual who is age 55 or older at the end of your tax year, your contribution limit is increased by $1,000. For example, if you have self-only coverage, you can contribute up to $4,400 (the contribution limit for self-only coverage ($3,400) plus the additional contribution of $1,000).

To qualify for the 55+ catch up contribution, you must be 55 within the tax year, be HSA eligible, and not be enrolled in Medicare – basically all of the stuff to be able to contribute to an HSA. The only addition is the age constraint thrown into the mix. This is generally easy enough for self-only coverage, but what do you do if your spouse is over 55 and you are not? Or, what do you do if both you and your spouse have separate Health Savings Accounts? You may be surprised to learn that the $1,000 can go on different lines on Form 8889 based on your coverage situation.

Catch Up Contribution follows the HSA Holder

A guiding principle is the $1,000 catch up contribution follows the HSA account holder, i.e. you or your spouse. To determine your household’s eligibility for a 55+ additional contribution, you must determine if the HSA account holder is age 55 or older by December 31st of the tax year. If they are, you can contribute to additional $1,000 to their HSA account.

The downside is your household may not qualify based on arbitrary factors of who opened the HSA and their age. For example, assume you are over 55 but your spouse is not. If your spouse owns the HSA, neither can contribute a 55+ catch up contribution for that year, until the spouse turns 55. Only then can one extra contribution be made, even though you are already 55 or older. Again, the 55+ contribution follows the account holder, so your age (as a non account holder) is irrelevant. The risk here is you may be shortchanging your household that $1,000 catch up contribution if the HSA account holder is younger.

[The way to get around this is, assuming you are on family coverage, to open an HSA in your name, so that you can contribute that $1,000 (assuming 55+) on top of the shared regular HSA family contribution limit. See next sections.]

Both Spouses have Separate HSA

Remember when we said earlier that the 55+ catch up contribution follows the HSA account? That also applies if you have family coverage and both spouses have their own HSA in their name. However, the rule still holds that only account holders 55 or older during the tax year can contribute the $1,000 catch up contribution to their HSA.

As another example, if you have family coverage with separate HSA’s and you are over 55 and your spouse is under 55, only your HSA can receive the $1,000 catch up contribution. Since this scenario requires the HSA’s to split the family contribution limit among them, for 2017 you will divide the $6,750 up however you like but your account must have the catch up contribution in it, if you make that extra contribution.

Thus, valid contributions for 2017 might look like this for the 55+ / < 55 accounts:

  • $6750 / $0
  • $0 / $6750
  • $3375 / $3375
  • $7,750 / $0 ($1,000 catch up used)
  • $1,000 / $6,750 ($1,000 catch up used)

In contrast, the following contribution combinations are invalid for 2017 for 55+ / < 55 accounts:

  • $0 / $7,750 (can’t put $1,000 in < 55 account)
  • $100 / $7,650 / $0 (must put all $1,000 in 55+ account)
  • $999 / $6,751 / $0 (must put all $1,000 in 55+ account)

Both Spouses 55+ and have Separate HSA

If both you and your spouse are over 55, have your own HSA’s, and are on family HSA coverage, you can both contribute the $1,000 catch up contribution to each of your HSA’s. For 2017, assuming full year coverage, this would be a household HSA contribution of $8,750 ($6,750 + $1,000 + $1,000). Again per Publication 969:

If both spouses are 55 or older and not enrolled in Medicare, each spouse’s contribution limit is increased by the additional contribution. If both spouses meet the age requirement, the total contributions under family coverage cannot be more than $8,750. Each spouse must make the additional contribution to his or her own HSA.

This is a secret HSA backdoor to increase your contribution limit above and beyond the stated family contribution limit, all by opening an HSA for each spouse. Many people don’t know that they can contribute so much money to an HSA as a family. Doing so should not bring additional cost, as it requires simply opening an HSA in your name. The cost being your time, a tax form, and perhaps an account minimum, but you gain an extra $1,000 / year in triple tax advantaged contributions.

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Medicare Part A Retroactive Coverage and HSA’s

Medicare Part A is a government administered health insurance plan generally for people aged 65 and older. It is a form of hospital insurance that covers inpatient hospital care, skilled nursing facilities, and other types of health care services. The general assumption is that Health Savings Account holders can maintain their HSA until they begin Medicare, and then easily hop onto Medicare Part A. As you will see, this may not be so, as there are some catches with Medicare Part A that affect your HSA eligibility based on your age and enrollment date.

People over the age of 65 do not have to sign up for Medicare; they can remain on a personal insurance plan (such as an HSA) as long as they want. However, once you elect to being coverage, or begin receiving Social Security, you are enrolled in Medicare Part A. While this not only ends your HSA eligibility (see next section), it may affect your HSA eligibility in previous months. For those who begin Part A coverage after they have turned 65, there is a clause that retroactively applies Medicare coverage. It states that your coverage start date actually begins up to 6 months prior to your actual enrollment date. From the Medicare.gov website:

If you sign up within 6 months of your (upcoming) 65th birthday, your coverage will start at one of these times:
1) The first day of the month you turn 65
2) The month before you turn 65 (if your birthday is on the 1st of the month
After that, you’re coverage will go back (retroactively) 6 months from when you sign up.

It is that last clause that can really affect HSA holders. It states that if you sign up for Medicare Part A after you turn 65, the coverage will retroactively be applied up to 6 months into the past. While this added “benefit” may be great and help cover some prior costs, it begs the question: what if I had an HSA during those 6 months of retroactive Medicare coverage?

Medicare Part A Affects HSA Eligibility

The short answer to the above question is “nothing good”. First things first, we need to make clear the requirements for being able to contribute to a Health Savings Account. Note that these requirements are for new contributions only; once you successfully contribute to an HSA, the funds they are yours forever. However the key word in that sentence is “successfully”, as you must be HSA eligible for the contribution to be valid. Per IRS Publication 969, HSA eligibility requires:

  1. You are covered by a high deductible health plan
  2. You have no other health coverage (few exceptions)
  3. You aren’t enrolled in Medicare
  4. You can’t be claimed as a dependent

Obviously, points 2 and 3 stick out like a sore thumb. In essence, you can be following the rules as an HSA eligible individual, and 6 months after the fact be retroactively disqualified (made HSA ineligible) due to Medicare Part A. If you are familiar at all with how HSA tax Form 8889 works, you know that this can pose some serious risks to your financial well being.

An HSA + Medicare Part A Nightmare Example

Here’s an example of how bad this can go. Paul turns 65 and becomes eligible for Medicare and Social Security but chooses to keep his day job as a bass player and to maintain his HSA eligible family insurance. Being in a lucrative field, Paul contributes the maximum to his family coverage Health Savings Account each year. In April of 2016, Paul chose to make a qualified funding distribution from his IRA to contribute the maximum to his HSA.

On May 1st, 2017, Paul plays the last show of his final farewell tour and decides to officially retire. He takes some of the proceeds from the show and contributes 4 months worth of a contribution to his HSA for 2017. No longer working, Social Security seems like a good deal so he signs up to start receiving benefits. This also enrolls him in Medicare Part A, which seems like free government sponsored medical care. Paul relaxes in his Palm Springs desert home and enjoys his retirement.

The next year, Paul gets a call from his tax accountant telling him his HSA Form 8889 is a mess and he may owe penalties and taxes. Because Paul was 67 when he signed up for Medicare Part A on May 1st, 2017, the coverage retroactively applied 6 months prior to November 1st, 2016. This means that he was not HSA eligible from November 2016 – April 2017. His accountant informs him that as a result, Paul has over contributed to his HSA for the 4 months in 2017 which will have to be removed. Even worse, his accountant tells him that the qualified funding distribution he made form his IRA in 2016 has been disqualified due to something called a Testing Period – Medicare made him ineligible for HSA contributions for 2017. That money is being taxed and penalized as well. Paul woefully reviews his financial statements and is upset as he thought he was everything by the book. Thinking it over, he considers booking a few reunion shows with his band mates back in LA.

How to Manage your HSA with Medicare Part A

Given the fact that Medicare Part A can retroactively disqualify you from being HSA eligible, it is best to prepare for such an event and plan accordingly. This involves a combination of 1) knowing if you are at risk for retroactive coverage and 2) planning your preceding and current HSA actions appropriately. As such, we recommend the following:

Determine when you will use Medicare Part A

If you are in your 60’s, you should be thinking about when you will sign up for Medicare Part A coverage, keeping in mind that this is also triggered by beginning Social Security benefits. If this occurs when you are age 65 and 1/2 or older, you are in the danger zone of having retroactive coverage applied. If this is the case, you will want to work backwards 6 months to plan your HSA accordingly. Will the 6 months fall within 1 tax year? Or is it possible that the 6 months will straddle 2 different tax years? By my count, the latter could affect HSA decisions you make up to 18 months in advance of enrollment!

Recalculate and Reduce HSA Contributions

If Medicare Part A applies retroactive coverage and makes you HSA ineligible for those months, you need to reduce your HSA contributions for that time frame. Remember, you are not HSA eligible if you are on Medicare, and thus cannot contribute to your HSA during those months. Instead you need to make a calculate your contribution limit for partial year coverage. For example, if you are 66 years old and have HSA eligible insurance for all of 2017, but then enroll in Medicare in December, you really were only HSA eligible for 5 of those months (since the final 6 months will have Medicare coverage). As a result, you can only contribute 5/12 of your HSA contribution maximum for that year. Many people get tripped up by contributing the full year amount early in the year, which leads to excess contributions once Medicare hits. Save yourself the headache and calculate your “true” maximum contribution early on and conservatively contribute that amount, knowing that you have until tax day to make prior year contributions.

Avoid the Last Month Rule and Qualified Funding Distributions

Retroactive Medicare Part A coverage wrecks the most havoc on HSA contributions that contain a Testing Period. These include the use of the Last Month Rule (to contribute more than normal in a partial coverage year) or the Qualified Funding Distribution (contribute to your HSA from an IRA). Both of these contributions require that you maintain HSA coverage for a given amount of time known as the Testing Period (up to 1 year). The risk is that do everything right and maintain HSA eligible coverage through the Testing Period, but then Medicare comes in and applies retroactive coverage. This in fact fails you for the entire Testing Period if you have Medicare coverage for even 1 month of it. And the worst part is that the penalties for this are fairly severe. They involve walking back your contribution amount, adding it to income, and applying a tax on top of it. You will want to carefully consider the timing of these types of contributions if you are over 65 and considering Social Security or Medicare Part A enrollment.

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